Despite optimism on new business volumes
and a bullish outlook regarding the potential for acquisition,
there is clear evidence from our research of the views of banks and
bank-owned lessors, independent finance companies, brokers and
captives, that a storm is now hitting the industry.

Worries over bad debt and
restricted availability of capital is resulting in tougher
underwriting criteria, reduced service levels and pressure to
reduce costs. While many lessors see opportunities in the current
fallout, our survey raises questions on whether all these ambitions
can be realised.

New business

Notwithstanding the credit crunch and recent turmoil in the
markets, over half of those taking part in the survey still expect
an increase in new business over the next six months – with most
anticipating an increase of over 5 percent (see chart 3).
Less than 30 percent predict a decrease in new business over this
period with the remainder anticipating no change.

Survey respondents from continental Europe, especially Belgium
and the Netherlands, are notably more optimistic than those in the
UK, where the effects of the credit crunch appear to be more keenly
felt. Independent finance companies are most optimistic about new
business volumes, nearly three-quarters of those surveyed predict
these will increase in the next six months with many expecting
growth in excess of 20 percent.

By contrast captives are less positive. None of those taking
part in the research expect business volumes to increase, while
most anticipate at best no change with a minority predicting falls
of up to 20 percent.

Margins

It is no surprise that many lessors are looking to improve
margins. Some 45 percent of respondents expect margins to increase
over the next six months with over 20 percent anticipating a rise
in excess of 25 basis points overall (see chart 8). No
more than 15 percent expect margins to fall and most of these
thought the decrease would be under 25 bps.

Banks or bank-owned lessors are the most aggressive on margins.
Nearly 80 percent of these expect margin growth over the next six
months with the majority predicting an increase in excess of 25
basis points.

Other groups are more mixed in their response. Under 40 percent
of independent finance companies expect margins to improve while
brokers and captives are clearly under more pressure with no more
than a third anticipating any form of improvement.

Underwriting

The result of more restrictive underwriting polices is evident
in respondents’ views on credit decisioning and acceptance service
levels.

Nearly 40 percent expect credit decision turnaround times to
lengthen over the next six months, compared to just 8 percent who
anticipate a reduction (see chart 4).

Expectations of longer decisioning times are most apparent among
brokers, perhaps indicative of more complex credits being brought
for approval and greater oversight of the underwriting process by
lessors.

Some 62 percent of respondents expect acceptance levels to
decrease over the next six months, compared to only 4 percent who
anticipate an increase (see chart 5).

The proportion expecting a decrease is again greater among
brokers suggesting either poorer quality credits being presented or
tighter underwriting criteria from funders.

It was also greater among UK respondents compared to those from
the rest of Europe, probably because the credit crunch has had an
earlier effect there than in other markets.

The survey asked how respondents expected underwriting criteria
to change over the coming months.

Several commented that policies were already much more
restrictive – there was a greater focus on the value of the asset
and in some instances additional security was being sought.

This was reflected in a general aversion to risk. Respondents
added that there was a greater emphasis being placed on return on
equity and yield (reflected in the anticipated increase in margins)
which was expected to tighten credit criteria still further.

Some noted that their underwriters were more rigorous in
requesting financial information – in a couple of examples,
underwriters were requesting current and forecast management
information instead of relying on historic audited figures as
previously.

Expansion

Respondents saw considerable variation in performance across
their portfolios. In terms of geographies, there is the recognition
that Spain and the UK have already been worst affected by the
credit crunch and no early recovery is expected in these
markets.

These will be followed by a stronger slowdown in the other major
European markets of Germany, France and Italy.

By contrast a number of respondents felt that CEE and emerging
markets such as Russia and the Middle East will prove more
resilient to the downturn currently affecting Western Europe.

Many expect the economic downturn to hit construction, vehicles,
IT, leisure and retail worse with volumes showing a more pronounced
decline in these sectors over the next six months.

It was difficult to identify any winners in this, though some
respondents thought that agriculture and the public sector would
buck the negative trend.

Many of those surveyed expect to reduce their focus on SMEs in
the coming months as this sector proves less resilient to economic
downturn than the corporate market and lessors seek a ‘flight to
quality’ in order to reduce risk.

Despite the downturn, over half of those interviewed said that
their companies are still targeting areas of growth. These growth
targets varied considerably; some were seeking to expand at a
geographic level in emerging markets such as Russia, the Middle
East and Africa while others were moving into niche vertical
markets such as food and agriculture, waste management, recycling
and renewable energy.

However, a number of lessors pointed out that these emerging
sectors would by no means compensate for declining volumes in their
traditional markets.

Acquisitions

Acquisition appears to be an increasingly popular growth
strategy with a number of survey respondents looking to acquire
portfolios or move into markets vacated by their competition.

It seems that the industry shake-out is set to continue across
Europe, with 71 percent of respondents expecting M&A activity
to increase over the next six months (see chart 9). This
trend is most apparent in the UK where over three-quarters of
respondents anticipate an increase in M&A activity, though it’s
worth noting that any acquisition activity is more likely to be
opportunistic rather than planned in the current environment.

Given their views on M&A it wasn’t surprising that almost
three-quarters of those surveyed expect the number of competitors
to fall in their home market over the next six months (see
chart 1).

Again this was most pronounced in the UK, and less evident in
Benelux, France and Germany where half the respondents thought that
the level of competition would remain the same.

In a similar vein, well over 80 percent of respondents consider
it unlikely there will be any new entrants in their home market
over the next six months.

With an overall reduction in the number of players in their home
market, nearly 60 percent of respondents expect the position of
their businesses to strengthen relative to the competition over the
next six months (see chart 12).

Only 6 percent expect it to weaken, while the remainder
anticipate that their competitive position will remain
unchanged.

The minority expecting their competitive position to weaken
cited access to and cost of funds as the main reasons while two
respondents commented that their organisations were exiting the
market or merging with another business.

It was notable that banks and bank-owned lessors were likely to
be less optimistic about their competitive position than
independent finance companies, brokers and captives.

Those expecting their position to strengthen attributed this to
reasons such as their captive market position, innovative products,
lending capacity, conservative risk policies and low cost base.

A number of respondents mentioned that their businesses had
taken action at the start of the credit crunch last year and feel
that they are now in a better position than their competitors which
didn’t move so quickly.

Is everyone a winner?

With most funders expecting to strengthen their competitive
position, questions must be raised as to how realistic these
assumptions are.

Only 40 percent of those surveyed expect leasing volumes in
their home market to increase over the next six months, whereas
over 50 percent expect their own business to grow.

Given that increasing market share is a zero-sum game, one
questions how many players are actually likely to grow their share
of lending, and which ones will in reality lose out.

Where funders decide to exit the market, existing portfolios and
customers will be redistributed among the other incumbents, in the
process allowing them to claim increases in market share. This is
unlikely to apply to all.

More importantly, capital investment growth is forecast to be
low throughout Europe, and credit quality will go down over the
next six months, so more companies will fall outside funders’
lending parameters.

Many of those seeking growth will either have to take on
business of questionable credit quality (unlikely to be supported
by credit departments based on current financial market behaviour),
reduce margins, or acquire.

In reality many will not achieve their intentions. Even
achieving existing business levels at current underwriting
standards when credit quality is declining will be a challenge.

A more pragmatic view

These bullish views concerning lending volumes and market share
were less apparent when it came to more operational aspects of the
business.

This was evident in respondents’ expectations of how the
conversion rate of sales leads would change in their business over
the next six months.

On this measure, respondents were divided with 28 percent
expecting it to increase, compared to 33 percent who expect a
decrease, while the balance anticipate no change (see chart
11).

Those expecting the conversion rate to decline cited an increase
in poor credit applicants, reliance on sales aid business, tighter
underwriting controls, and a more cautious attitude towards
residuals as reasons for the change. Respondents predicting an
increase attributed this to changing their business mix, moving
into a variety of new areas such as sale and leaseback, small
ticket deals and direct sales to end-use customers.

Bad debt is an issue for many of the organisations covered in
the survey. A small but notable minority said their bad debt levels
would rise by over 25 percent over the next 6 months, and two
respondents forecast an increase of over 50 percent for their
companies.

This research also confirms the constraints on access to capital
which have been evident in the sector. Assuming that gearing ratios
remain unchanged and finance providers have historically operated
to their capital limits, a reduction in capital for almost
two-fifths of funders would drive a large swing of new business
volumes toward adequately capitalised firms with available
capacity.

Meanwhile, finance providers having to reduce new business and
portfolio size as a result of capital restrictions are likely to
experience reduced operational efficiencies and an operating
infrastructure operating well below capacity.

Clearly we are in period of seismic change. The impact of the
credit crunch can be seen in restricted availability of capital,
tighter underwriting criteria, cost reductions, and aversion to
risk. If the anticipated reductions in staff come to pass, this
could have a big impact on the industry.

Nonetheless the survey findings are not as pessimistic as events
elsewhere in the finance industry would suggest. Is the asset
finance sector in denial or is it more robust than other finance
sectors under the cosh?

Working capital

Over half of Europe’s lessors predict bad debt will rise, while
fewer believe available capital will fall

There is little optimism apparent when it comes to bad debt.
None of the respondents expect this to fall during the next six
months (see chart 2).

Nearly two-thirds of those surveyed thought bad debt would
increase, though most believe this increase is unlikely to exceed
25 percent. The remaining third expect bad debt to remain the
same.

Banks or bank-owned lessors appear more sanguine over bad debt
with over three-quarters expecting this to increase over the next
six months.

Brokers and independent finance companies are more evenly
divided between those anticipating an increase and others expecting
no change.

This is possibly because these brokers have less of an issue
with bad debt (although it may affect their clawbacks), while
independent finance companies were perhaps more choosy in their
credits in the first place.

The research supports evidence of a relationship between margin
growth and bad debt. Nearly three-quarters of those anticipating
margins to increase also expect an increase in bad debt. Perhaps
funders are looking to increase margins in order to cover a growing
bad debt ratio, or there is a growing recognition of the need to
achieve a return on the increasingly scarce liquidity available to
them.

The impact of the credit crunch was also apparent in the
question on availability of capital. Just over half of those
surveyed expect capital availability for their business to remain
the same but 37 percent expect this to decrease over the next six
months – typically by up to 10 percent (see chart 6).

Given the impact of gearing, this could be highly significant
for future lending and potentially make a big hit on profitability
if costs remain unchanged.

The proportion of those interviewed anticipating a reduction was
higher among banks or bank-owned lessors – which probably explains
why banks are less bullish about growth right now – but lower among
independent finance companies.

Only 11 percent expect more capital to become available during
this time frame.

Costs

European lessors expect cuts in marketing budgets, but less so
their staff numbers, except for the UK

It would be expected that a less favourable business environment
would lead to a clampdown on operating and discretionary
expenditure.

To some extent this was true, but by no means across the
board.

The survey questioned respondents on what changes they expected
in operating, marketing and training expenditure over the next six
months.

Operating expenses appear to be the least affected. Just over 30
percent expect these to be cut over the next six months, in most
cases by less than 10 percent.

Some 27 percent actually predict them to increase, again by less
than 10 percent while over 40 percent anticipate no change (see
chart 10).

By contrast, marketing expenditure looks like it will take a
greater hit.

Some 43 percent of those interviewed expect this to be cut over
the next six months, with 14 percent anticipating a reduction of
between 10 percent and 25 percent, a significantly higher
proportion than the other three areas measured.

Only 19 percent expect an increase in expenditure, mostly of
less than 10 percent. Bank-owned lessors and captives are most
likely to cut marketing spend while brokers are more likely to
predict an increase.

It also seems that a higher proportion of respondents from the
UK expect marketing expenditure to be cut compared to those in
continental Europe.

The outlook for training appears to be marginally better,
although half the respondents expect training budgets to be
frozen.

Nearly one-third anticipate that budgets will be cut, with 18
percent predicting a cut of over 10 percent over the next six
months.

Only 20 percent of respondents expect training budgets to
increase, a similar proportion to marketing. Mirroring the same
pattern as marketing, a higher proportion of respondents in the UK
anticipate a cut in training budgets compared to those elsewhere in
Europe.

Among the business types, captives appear to be more likely to
cut training compared to brokers and other lessors.

Overall, it is notable that bad debt is a key driver of costs.
Companies expecting bad debt to increase over the next six months
were two to three times more likely to be cutting costs. This
applies across all areas – operating, marketing and training.

The research looked at respondents’ expectations of how staffing
levels would change in their organisations over the next six
months.

Sales staff seem to be least affected by the economic downturn,
with over 30 percent expecting their numbers to increase against 22
percent anticipating a reduction (see chart 7).

Sales staff cuts are largely confined to the UK with one-third
of UK respondents expecting their organisations to cut sales staff
over the next six months against just 7 percent from the rest of
Europe – unsurprising given the greater levels of employment
protection typically offered outside the UK.

The survey indicated that staff outside of sales are more likely
to experience cutbacks.

Although half of those surveyed expect no change in staff
numbers, a third predicted cutbacks of up to 15 percent over the
next six months.

Only 16 percent expect non-sales staff numbers to increase, and
for most the increase in numbers will be marginal, under 5
percent.

Again, a higher proportion of reductions are anticipated in the
UK with 43 percent of respondents expecting reductions compared to
15 percent for the rest of Europe.

It seems that non-sales headcount will be reduced across a range
of functions, predominantly administration and back office, and
finance, sales support, deal administration and legal were
specifically mentioned.

The authors are partners at Invigors